For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

My daughter Morgan likes to play Life, the classic board game that takes you from college to family to retirement with several spins of a wheel. At one point, all players must stop their colored car tokens at a fork in the road on the game board and decide on taking the “risky” or “safe” path of life. The risky path, naturally, has greater potential for financial rewards than the safe path, but also greater potential for financial losses.

The “risky or safe path” is one of my favorite parts of Life, as it provides a glimpse into players’ views on risk. Just 7 years old and fairly impulsive, Morgan prefers the risky path. I, her older and “wiser” father, carefully weigh all the factors: Am I winning (i.e., do I have the most money)? How have I fared taking the risky or safe path in the past? And how soon is Morgan’s bedtime? (The safe path is a little shorter.)

In my real life as a Vanguard financial advisor, a favorite part of my job is helping people determine which path to take when it comes to their money—especially in terms of asset allocation. It’s an area where I see many of my clients struggle. It’s easy for uncertainty to cloud judgment and to end up with a portfolio having too much risk, or too little. And unfortunately, those less-than-optimal allocation decisions cost real dollars instead of game dollars.

Here are a few points about risk and allocation that I advise clients to keep in mind:

1. Allocation often doesn’t match age

Most people know the old “Hold your age in bonds” or “100-minus-your-age in stocks” asset mix formulas. These rules of thumb offer good starting points for allocation decisions, but are not perfect. In fact, I find that in most cases a suitable asset allocation doesn’t match an investor’s age—such as a legacy-minded 80-year-old maintaining an entirely appropriate 80% stock, 20% bond allocation.

2. It’s possible to “cheat” on the risk quiz

Quizzes like Vanguard’s investor questionnaire give a better indication of a suitable allocation than age-based formulas, since they take into account possible investor behavior during times of stock and bond market volatility. But again, results are just a starting point. For example, very risk-averse clients with whom I’ve spoken received recommendations of high-percentage stock mixes based on their quiz answers. And more than one client has told me, with the proverbial wink of an eye, how they took the quiz multiple times and changed their answers to get their desired results.

3. The markets will steer you wrong

The worst influence on allocation is recent market performance. I’ve spoken with many clients holding large amounts of cash for the last several years, worried that the stock market was too high and bond yields were too low, a decision that ultimately hurt their portfolios. Then there were parents who kept their kids’ 529 college savings allocated mostly in stocks through 2008, only to be left scrambling to find another way to pay their tuition bills during the financial crisis. Markets change too quickly and unpredictably to be a reliable foundation for deciding on an asset mix.

4. Your asset mix should reflect you

Ultimately, the foundation for an asset allocation decision should come down to just one thing:

You.

“You” as reflected by your goals. Yourtime horizon. And yourrisk tolerance. These 3 factors don’t tend to change much in the short term but should evolve over the long term. That makes them much more reliable for determining the allocation that will provide the best chance of achieving financial success. But oddly enough, they are also the same factors that many people forget in their decision-making process.

What does that extra risk achieve?

A few years ago I spoke with a couple in their 60s who wanted help deciding on their allocation as they headed into a secure retirement. They had a 7-figure nest egg and modest spending needs that would be covered by a pension and Social Security benefits. With no kids, they just wanted to ensure they could cover large potential expenses, such as long-term care, and not run out of money.

Their risk quiz results recommended a moderately aggressive 60% stocks, 40% bonds—which the husband thought was too conservative. “We’ve had mostly stocks all our lives,” he told me. “With my pension, we can take on more risk. Besides, bond yields are just so low. I can’t see putting more money there.”

“Well, yes, you certainly can allocate more toward stocks,” I replied. “But given your portfolio’s size, you’ve already achieved your goal of financial security. And you told me you’re unconcerned about how much money passes to family or charity. So let me ask you: What will taking that extra risk achieve?”

The question seemed to take him aback. He paused and gave it some thought. “That’s a good question,” he finally said. “Nothing, really … but greed kicks in.”

We decided on 60/40.

The path that will serve you best

Asset allocation is the most important decision you make with your portfolio. Take the risky path or the safe path, but understand the pros and cons of each, and how they relate to your situation. The mix that reflects you best is the one that will serve you best—no matter which space upon the path of life you land.

Notes:

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

All investing is subject to risk, including possible loss of principal.

Chuck Riley

Chuck is a senior advisor in Vanguard Personal Advisor Services®. He joined Vanguard in 1998 and previously worked in Vanguard Marketing and Communications. Chuck is a Certified Financial Planner™ professional with a bachelor's degree from the University of Washington.

Comments

Richard G. | April 26, 2017 9:14 am

To Mr. Riley: I so appreciated this article and as usual most informative and thought provoking.There are so many areas that influence how you set up your program that may NOT be financially based.Mr. Riley and other writers at Vanguard have counseled their readers to look at your WHOLE investment picture.Debt structure is a Biggie.If you are elbow deep in debt then a good part of your retirement will have to be committed to reducing your debt load.Can you take employer medical benefits with you in to retirement? If you cannot then you had better get as close to age 65 as possible or you are in for an eye-opening quest trying to secure coverage for you and your spouse and pay individual rates! Some vanguardians retire without employer retirement and must make their hay using almost 100% of their personal investments to live on.What is one persons strength is anothers achilles heel.Vanguard is a proponent of broad based investing if for no other reason is that it will keep you from falling off of the proverbial financial cliff.I started with Vanguard with a 44 year financial foundation from my job.I buy the whole market,including bonds and I buy low and sell high. Good Luck to All! It is great being an owner of Vanguard!

Nirs V. | November 11, 2015 4:28 pm

Hi,

It was a wonderful article followed by a very good insight from some of the experienced investors. As someone rightly pointed out, the DCA comes very handy more to build the nestegg in a disciplined manner with an added advantage of easing out market volatility. I’ve a question related to asset allocation. Do you have any comparison analysis of 100% stock vs 80/20 Stock/Bonds vs 50/50 Stock/bond over the last 25-30 years. I’m a 35 DIY person with reasonable understanding of personal finance and doing DCA 100% in stock in my 401K & IRA.However, I’m yet to get convinced why should we keep bonds in portfolio if planning stay in market for a long haul 30+ years and have ability to stomach (paper loss). I understand that 100% stock is a super risky if we’re planning to touch the funds within 5 years, but why bother if the ride is long? I personally feel that having bonds in a portfolio with the above profile is like riding the car with parking break on!!

Can anyone share his experience or some study/whitepaper to evaluate the clear effects of having all stock vs mixed portfolio over a long haul?

Rajesh C. | November 5, 2015 9:17 pm

Although i have been retired now for 6 years and survived a on 50/50 portfolio. i have the same principal which was 500000.00. Now i am scared for the future. will i able to survive on this alloacation for next 20 years. my ss is 19000.00 a year.

Donald G. | February 8, 2016 11:42 am

To Rajesh C. 11-5-15 9:17 p.m. Sir you do not give any where close to enough information about your financial history in your blog.I would suggest contacting Vanguard and talk to a crew member or a CFP.Your ability to survive for the next 20 years with a $19,000.00/yr S.S. check and a portfilio of a 1/2 million will be decided on a number of things that a financial professional would have to find out about you.What is your age, are you married, do you or your wife have an employer provided retirement,is she elligible for S.S if so when and for how much, what is your portfolio invested in- a regular IRA,401k,Roth???????Once your Vanguard professional knows what you have now and how it is invested,then and only then can they counsel you in how to reach your goals. Good luck to you Sir!

Stuart M. | September 27, 2015 10:42 am

My view is very “ho humm'” and nothing you have not read many times. But, at 84 and a lifetime investor, the Vanguard advice rises to the top, like cream in the old glass milk bottles. Age is the cursor, and of course there are exceptions (but not many good ones). The risk/reward advice (20% Stocks/80% Bonds) for us has developed into a very workable, realistic and profitable strategy. That opinion remains, recognizing the current bond discomfort as a part of a long and established cycle. Stick with it and do not run to the nearest exit, a sure plan for failure. There is a saying in the Market: It’s OK to be a bear, It’s ok to be a bull…but don’t be a pig!!

Oh…one more thing, the fourth reincarnation of Dearth Vader at the Fed, unfortunately, is all a part of the cycle. Smile and let it pass.

Richard G. | September 21, 2015 10:10 pm

Well Folkes to me one of the first things that you have to do is pick an asset allocation that you can live with and will accomplish your stated goals.You have to lay a foundation .that may or may not be in the market. For me I have laid my foundation by getting to retire on four retirement checks.Also another key word is to be “debt free”. One thing that Vanguard allows you to do is buy the whole market cheaply using index funds.I will always stay invested in the market. I could care less what the Wall Street “guessers” say or anyone on any financial network. Also I firmly believe you need to have a healthy cash cushion available at all times to give you a solid buffer to your controlling when to sell not when the market goes through a correction.Every year or when my program goes below a 5% plus or minus from my 70/30 asset goal I rebalance. Whatever has gone up I sell and whatever has gone down I buy.Now it is hard to buy in a falling market but you have to show a little backbone and realize that that is the exact time to buy while shares are cheap.I have read just about all of Mr. Bogles books and two things that I have always remembered is No one on the face of the earth knows what the market is going to do -“in advance” and always buy low and sell high. Vanguard is so nice to help me make a lot of money. I look forward to my RMD time because I am still going to “buy low and sell high”. Good Luck to All.

Thomas B. | September 3, 2015 6:05 pm

A co-worker, who was involved with the company’s pension plan, told me to consider a pension as the dividends of a bond fund. It is a little tough to determine the value of such a fund this way for portfolio balancing, but since my best guess of the value of the bond fund is 60-70% of my investments, I just ignore it.

By the way, the Game of Life has been rated as one of the worst board games. The basis of this statement was the number of Life games that were available for resale after Christmas.

Richard G. | July 24, 2015 5:56 pm

Fellow owners of Vanguard:How we look at our Asset Allocation while we are working is quite a bit different when you set it up AFTER you retire.For one thing you cannot add any more to your 401k,IRA,etc.etc. because you will no longer have any earned income.So your adjustments to your tax-sheltered money will consist of rebalancing only with money that is within the IRA at the time of your retirement.My wife and I are lucky because we have four federal checks with cost of living riders. I consider these checks as a rock solid floor of our portifolio.We have already worked for 40 plus years to get these benefits and yes I consider them equal to a bond investment. i have set up our program for maximum growth and I will keep investing agressively like this until we reach seven figures.Right now I am sitting on my IRA money for eight years until RMD’s at 701/2.At the time of the first taxable check that is sent to you at the RMD schedule rate then you have to learn about keeping your program in balance using both tax-sheltered and taxable money. If the good Lord lets you live long enough you are eventually going to have more taxable income than is in your IRA. One thing that I am a firm believer of is keeping a healthy emergency fund.I do not care what the day to day market is doing because I do not let myself get into a position where I have to sell stocks at a loss because I do not have a robust cash cushion. Good luck to all in managing your various portifolios.

Anne L. | August 29, 2015 3:14 pm

Donald G. | September 7, 2015 7:56 pm

To: Ann L Aug. 29, 2015- The best way to save on taxes while withdrawing from your IRA is just take out the minimum that Uncle Sam requires.Depending on the balance in your IRA This should keep you in the 15% tax bracket. If you did not want to be taxed on the proceeds after it is brought out and put in a taxable arena then you could invest in some muni’s for example sold in your state of residence. While the money earned from the bonds is not taxable your trade off for the no tax is a paltry return on these bonds. Good luck in your retirement.

I’ve always wondered how to calculate pension income into an allocation mix. Throughout my retirement saving period, I regarded the pension as the “third leg” on the stool – social security, pension, and investments, with the pension being roughly equivalent to bond investments. But I didn’t really know how to calculate that in to the moving target of retirement. I kept around 75% in stocks throughout my saving period and never adjusted it, partly because the success of my investments led to retiring earlier than I thought I might. As a result I have recently retired with a high percentage of my portfolio in stocks (like Paul, above – Paul, your comment opens my eyes to a new long-term consideration and I appreciate this.)

But there’s still the problem – how do you factor in pension income when calculating a desirable allocation (which in my case is coming up 60% bonds 40% stocks: a big adjustment to make.) Somehow assign a cash value to the pension and call it a bond?

Also I confess to being unable to mentally transfer the way bonds work mathematically to an intuitional understanding, which leaves me rather uncomfortable with them: I need to run the numbers of the history of my bond holdings until it sinks in better.

Paul D. | July 22, 2015 10:22 am

Connie,
Like you, I too have struggled with understanding bonds. They just seem so convoluted to me and the differences in bond mutual funds vs. standard duration bonds can be intimidating. I myself, do not count social security in my allocation, but see that many others do. I do not know which is better, or preferred.

Having said all that, much of the way you think about your pension vs. bonds will depend upon the types of bonds you hold and the nature of your pension (i.e. guaranteed lifetime, fixed payment etc.). Some people treat their social security as a lifetime bond or annuity.

This topic can be so fraught with variables that I suggest you take advantage of Vanguards new service “Partnering with an Advisor” or at least check it out. If you have an account with Vanguard, the minimum holding is very reasonable for you to work with one of their financial professionals for no other cost. I have not used it but am giving it considerable thought as my investing options become more complex and I’m not getting any younger.

Ted S. | July 22, 2015 11:59 pm

Here is a rough but meaningful way to calculate an “asset allocation” that includes (a) promised future payments from Social Security or pensions with (b) the value of assets such as stocks, bonds, and the mutual funds that hold them.

For brevity, I’ll just address the value of Social Security benefits. These are far and away most people’s most valuable financial assets — PROVIDED THAT the current federal policy of increasing annual Social Security payments in line with overall price inflation is continued in the future. (That’s a political issue.)

Assuming that Social Security payments continue to increase with inflation, the “present value” of a person’s future payments is, essentially, their current annual payment times the number of years that they will live. For this calculation ONLY, they can assume that will be 100 years. So, for somebody who is 65 with 35 years to 100, the present value of an SS benefit of $1,000 per month ($12,000 per year) is about 35 x $12,000 = $420,000. This is essentially the same as a bond valued at $420,000.

So, ONE way of considering asset allocation would be to count this $420,000 with other bond holdings. But in calculating their asset allocation in this way, retirees whose other financial assets are less than the present value of their Social Security and pension benefits should be content to have their allocation to stocks as low as 15%, for reasons I can’t fully explain with the limits on “characters” in this commentary.

Paul D. | July 23, 2015 11:55 am

A very understandable explanation of calculating future value of social security benefits Ted. Perhaps it will aid Connie in her quest to integrate social security (and possibly pension) into her portfolio allocation.

I do not include social security in my portfolio because it ceases to exist as a functioning asset at the same time I do. Of course I’ll be dead and wouldn’t care at that point, but my plan is to leave some sort of legacy to my grandchildren. I don’t think I will be able to do that as well if a portion of my portfolio croaks at the same time I do.

Although, for planning and ‘living’ purposes, I can agree with what you propose with one caveat, and that is the lowered percentage of stock in the portfolio. Particularly, if the total of all your current remaining assets are less than the present value of your social security. Of course all that depends on ones age and what ones plan and portfolio were assembled to achieve in the first place.

Garland R. | August 21, 2015 10:08 am

Thanks for your post Ted S. I enjoy playing around with different scenarios and hypothetical number combinations dealing with retirement benefits, investments, longevity etc. Your post makes sense but of course the big unknown is longevity or lack of as may be the case, hence the reason I took social security at 63 1/2. Based on the assumptions I am now a multi-millionaire but in reality I am comfortable, pretty much where I wanted to be. However; the main reason I responded is just to say thanks because your post put me to thinking. I am 2 plus years into retirement with social security and two small pensions and have been putting a lot of though into how to consider these in my financial plan. It also reminded me that my personal portfolio is a bit too aggressive plus I am sitting on too much cash which is basically earning nothing. Like a lot of people I did this hoping for stability in the markets, in my case waiting for a correction to get my cash back in the market, but based on the last couple days I guess most would have wish myself good luck with that and get on with reality. Just one more point; I started investing with Vanguard through my work IRA and sticking with them was one of the better choices I’ve made in life. Don’t mean to ramble and thanks again.

David S. | September 17, 2015 3:23 pm

@Ted – I would take a different approach to capitalize the value of Social Security and or pension benefits. Let’s suppose the SS benefit is $30000 per year. What lump sum would be required to reliably generate a cash flow of $30000/yr for a typical retirement horizon of 30 to 35 years. Using the oft recommended 4% withdrawal method in reverse, it would require a lump sum of 30000 divided by .04 or $750000. Financial planning models (incluiding Vanguard) I have seen would indicate a lump sum of $750K invested 60% equity 40% bond would provide a cash flow of $30K per year adjusted annually for inflation for a 30 to 35 years before depleting the portfolio with a liklihood of over 85%. Therefore, for purposes of asset allocation of a retirement portfolio, I would value a SS benefit of $30k/ year at $450K equity and $300K bond.

Jeff C. | July 23, 2015 9:07 pm

Connie,
We don’t include Social Security, pensions or employer annuities in our retirement portfolio; I think of them as inflation-adjusted income streams to meet retirement living expenses. We kept a detailed budget for three years before we retired that included all of our expenses (taxes, mortgage, travel, vehicles, insurance, etc.), except contributions to retirement funds. Then we estimated our living expenses in retirement, which turned out to be about 90% of our pre-retirement expenses (federal and state taxes went down, but our travel and healthcare costs went up). We then subtracted our retirement income from our estimated expenses (we’re waiting to take Social Security). We withdraw the difference from our investment portfolio. Withdrawals have been less than 2% of the portfolio, a sustainable withdrawal rate over a long retirement. Using data on page 4 of “Vanguard’s Framework for Constructing Diversified Portfolios (Vanguard Research, April 2013), we set our allocation at 40% stocks and 60% bonds (ave annual real return 4.7%, ave nominal return 7.8%, max return 28%, max loss 18% over 87 years). Five years pre-retirement we were at 70/30 stocks/bonds; when we retired two years ago, we were 60/40; now we’re 45/55 on our way to 40/60. Our expenses since we retired have been 10% less than we estimated, but are likely to increase with longer trips to more expensive countries. There’s no need for us to take more risk with a higher allocation to stocks.

Thanks for your comment, Connie! And congratulations on achieving an early retirement! Like you, many investors I speak with don’t know how–or whether–to factor in a pension or Social Security, as Paul D. pointed out, into an allocation. Should they treat it like a bond? Cash? Neither? In such cases, I have a discussion similar to the one in point #4 of my post: Whether you have a pension, Social Security, or both, your asset mix should reflect you. If your goal is to continue growing the portfolio as much as you can, you’ve got a long time horizon, and fluctuations in the market don’t phase you, a higher stock allocation is okay, even in retirement. If, like the couple in my example, you’ve accumulated the amount you need, you’re more interested in preservation rather than growth, or the potential downside of stocks cause you to lay awake at night (hopefully not the reason you are replying at 1:44 a.m.!), then increasing your bonds could be the better option. The right allocation depends primarily on what you’re trying to achieve with your portfolio, not necessarily what you calculate your pension and Social Security benefits to be worth. Hope this helps! -Chuck

Ted S. | July 21, 2015 1:23 pm

I’m not familiar with the game of “Life,” (although I am familiar with the joys of raising a daughter and teaching her about principles of success in life that include personal finance).

One of those principles is that an American with some money to invest has a practically infinite number of choices for doing so, involving a wide range of levels of “risk” related to a multitude of largely unpredictable factors affecting both individual businesses and the world economy. So, it’s not a simple matter of choosing between a single “low risk” or “high risk” strategy.

My general solution is to use “low risk” investments to fund basic needs, including those that could be anticipated with reversals of fortune such as loss of employment and/or drops in the value of stocks or other assets. (And people should have insurance to cover personal misfortunes.) “Excess” funds can then be invested in riskier assets (particularly, a set of stocks that is diversified among industries to limit its risk) that presumably have the best chance of substantial appreciation over an extended period of time.

As to “low risk” investments, I regard U.S. Treasury Inflation Protected Securities (TIPS) as providing the best guarantee against any substantial loss of purchasing power. Vanguard has several funds and ETFs that invest in a selection of TIPs, and people should also consider purchasing individual issues that will mature on specific dates, such as their expected retirement date.

Paul D. | July 21, 2015 11:57 am

I enjoyed reading your post Chuck, it brought back my own memories of playing that game a very long time ago.

I also agree with Scott that ultimately this is the best advice a young investor could receive….providing they develop the discipline to adhere to it as time (plus Bull & Bear markets) pass.

I am 73, retired 13 years and have had essentially the same allocation for roughly 15 years (70-30) but like the couple in your example, I have begun to slowly work towards the 60-40 split.

My problem is the expensive capital gains tax. The prospect of paying this tax really complicates the reallocation of my portfolio. Nearly all my stock holdings have HUGE capital gains…the worst one has a basis of $.08/share that is now trading at over $100/share. As a founder of that company, I was under SEC restrictions on selling that stock for a long time, when in actuality, I should have been diversifying. The other problem was of course that investors don’t like to see small company founders selling stock because it raises red flags to them.

Fortunately my Vanguard holdings are both sufficient for retirement and fairly tax efficient, so I may just leave the stock to my heirs so they should get a step-up in basis (unless the wizards in Washington change that too).

I’m glad you found the post helpful, Paul! As you and Scott point out, discipline is key to giving yourself the best chance of investment success, as is diversification. Shifting to a bit more conservative and diversified mix in your situation sounds sensible, although taxes can be painful. If it’s any consolation, a high tax bill for your investments also mean that you did well with them. Best wishes! -Chuck

James C. | September 2, 2015 9:01 pm

Paul, I would suggest that your highly-appreciated stock would make an excellent charitable gift to, perhaps, your local community foundation. You would receive a tax deduction at today’s value with no taxes due on the gains.
The gift could be used to create an endowment fund from which future earnings could support your church or other causes about which you care in your community…into perpetuity.
Just a thought…

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.